Tuesday, January 24, 2012

What did Adam Smith think of externalities associated with the efforts of individuals to improve their relative position?

I have
enjoyed reading Robert Frank’s new book, ‘The Darwin Economy: Liberty,
Competition and the Common Good’, more than I thought I would. This may be because
I felt that the book had been written for people like me - the author seems to
want people who have a strong regard for individual liberty to give serious
consideration to his views.

I had
expected Frank to argue that competition for positional goods involves a
negative externality because those who are most successful are envied by many
of those who are less successful. However, the view he presents of the nature
of externalities associated with competition for positional goods is more
subtle and less easily dismissed.

The starting
point of Frank’s analysis is the ‘invisible hand’ of the market, which Adam
Smith had suggested in ‘Wealth of Nations’ leads self-interested individuals to
promote the greater good of society, without intending to do so. Frank
describes Smith’s invisible hand as ‘a genuinely groundbreaking insight’, even
though, as Smith recognized, the invisible hand ‘breaks down’ to some extent in the presence of externalities,
public goods, and so forth. The particular negative externality that Frank is
most concerned about in this book is associated with circumstances where
individual rewards depend on relative performance and result from the strivings
of individuals to improve their relative position. He contrasts this striving to
improve relative position (which he describes as Darwinian competition) with
the benign competitive forces associated with Adam Smith’s invisible hand.

Frank’s
discussion of the different views of competition that he attributes to Darwin
and Smith reminded me that Adam Smith had actually written about the strivings
of individuals to improve their relative positions in ‘The Theory of Moral
Sentiments’ (TMS). Smith suggested in TMS that what people hope to achieve by
bettering their condition is not ‘ease’ or ‘pleasure’ but ‘to be taken notice
of with sympathy, complacency and approbation’ (p 50-51, Liberty Fund edition,
1982). Later in the book, Smith suggests, however, that ‘the poor man’s son,
whom heaven in its anger has visited with ambition’ imagines that if he attained
wealth and greatness ‘he would sit still contentedly, and be quiet, enjoying
himself in the thought of the happiness and tranquillity of his situation’.
According to the story, this ambitious man endures a great deal of misery
striving to better his position. By the time he achieves his goal, however, he
is near the end of his life ‘his body wasted with toil and diseases, his mind
galled and ruffled by the memory of a thousand injuries and disappointments …’.
At this point he begins to think that ‘wealth and greatness are mere trinkets
of frivolous utility’ offering little ‘ease of body or tranquillity of mind’ (p
181).

In my view,
Smith’s story understates the benefits that people obtain from wealth because
it doesn’t take account of the greater autonomy wealth enables them to enjoy. (I
have discussed the link between wealth and autonomy previously on this blog.)

Smith was
suggesting that people tend to make cognitive errors of the kind discussed by
Daniel Gilbert in his book, ‘Stumbling on Happiness’. This view of strivings to
improve relative position differs from that of Robert Frank, who does not rely
on departures from the individual rationality assumptions normally used in
neo-classical economics.

The
similarity between the views of Adam Smith and Robert Frank in relation to strivings
to improve relative position lies in the fact that both seem to see this as
more or less a zero sum game, with externalities involved. Adam Smith wrote as
follows about the externalities associated with the strivings of individuals to
better their condition:

‘The
pleasures of wealth and greatness … strike the imagination as something grand
and beautiful and noble, of which the attainment is well worth all the toil and
anxiety which we are apt to bestow upon it.

And it is
well that nature imposes upon us in this manner. It is this deception which
arouses and keeps in continual motion the industry of mankind. It is this which
first prompted them to cultivate the ground, to build houses, to found cities
and commonwealths, and to invent and improve all the sciences and the arts,
which ennoble and embellish human life; which have entirely changed the whole
face of the globe, have turned the rude forests of nature into agreeable and
fertile plains, and made the trackless and barren ocean a new fund of
subsistence, and the great high road of communication to the different nations
of the earth’ (p 183).

These days
many people would be less inclined to count as a benefit some of the ways in
which the face of the globe is being changed by the motion of industry. But
Smith’s insight that strivings of individuals to improve relative position can encourage
technological progress is still relevant. If such strivings also result in negative
externalities, those need to be balanced against the positive externalities
that Adam Smith identified.

Yes Lori, and it isn't just in Lake Wobegon that most people think they are above average. But if most people think they are above average now, that seems to me to indicate widespread complacency about relative position and to count against the view that everyone is scrambling to get higher in the pecking order.

By the way, I think that life has become much more of a positive sum game since Adam Smith's time (and partly as a result of his influence). There are now greater opportunities for people to get ahead through engaging in economic activities that increase the opportunities available to others, rather than rent seeking, which reduces the opportunities available to others.

In the times the financial crises across the world, everyone is now questioning all the fundamental and modern theories in economics and trying to review and suggest what they feel. And this book I think is on the same line as your post suggests. Competition is something that was there in Darwin's theory and also in Smith's theories. Sometimes in name of natural selection and sometimes invisible hands..........

Emancipation

Welcome!

Welcome to Freedom and Flourishing. While you are here, why not take a look around and leave some comments.

There is a list of my most popular posts below. I am pleased that a post about characteristics of a good society, that I wrote in 2009, is still one of the most popular. That post captures some of the ideas about freedom and individual human flourishing that I think are most important.